The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Hongbo Co.,Ltd. (SZSE:002229) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for HongboLtd
What Is HongboLtd's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 HongboLtd had debt of CN¥460.8m, up from CN¥373.4m in one year. But on the other hand it also has CN¥860.4m in cash, leading to a CN¥399.5m net cash position.
A Look At HongboLtd's Liabilities
Zooming in on the latest balance sheet data, we can see that HongboLtd had liabilities of CN¥644.3m due within 12 months and liabilities of CN¥231.6m due beyond that. Offsetting this, it had CN¥860.4m in cash and CN¥275.7m in receivables that were due within 12 months. So it can boast CN¥260.2m more liquid assets than total liabilities.
Having regard to HongboLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥18.5b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that HongboLtd has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HongboLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year HongboLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 16%, to CN¥633m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
So How Risky Is HongboLtd?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months HongboLtd lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥246m and booked a CN¥61m accounting loss. With only CN¥399.5m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for HongboLtd that you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.